☒ QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30,
2017

or

☐ TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from _________
to _________

Commission file number: 333-150332

DRONE AVIATION HOLDING CORP.

(Exact name of registrant as specified
in its charter)

Nevada

46-5538504

(State or other jurisdiction ofincorporation or organization)

(I.R.S. EmployerIdentification No.)

11651 Central Parkway #118, Jacksonville,
FL 32224

(Address of principal executive offices)
(zip code)

(904) 834-4400

(Registrant’s telephone number, including
area code)

Not applicable.

(Former name, former address and former
fiscal year, if changed since last report)

Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes ☐ No ☒

Note: The registrant is a voluntary
filer, but has filed all reports it would have been required to file by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months if it was subject to the filing requirements thereof.

Indicate by check mark whether the registrant
has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth
company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting
company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

☐

Accelerated filer

☐

Non-accelerated filer

☐

Smaller reporting company

☒

(Do not check if a smaller reporting company)

Emerging growth company

☐

If an emerging growth company, indicate by check mark if the registrant
has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided
pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒.

As of August 3, 2017, there were 8,932,470 shares of registrant’s
common stock outstanding.

Indicate by check mark whether the registrant
is an “emerging growth company” as defined in Section 2(a) of the Securities Act and Section 3(a) of the Exchange Act.
Yes ☒ No ☐

Indicate by check mark whether the registrant
has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided
pursuant to Section 7(a)(2)(B) of the Securities Act and Section 13(a) of the Exchange Act. ☐

DRONE AVIATION HOLDING CORP.

INDEX

PART I. FINANCIAL INFORMATION

ITEM 1

Financial Statements (Unaudited)

F-1

Consolidated Balance Sheets as of June 30, 2017 (Unaudited) and December 31, 2016

F-1

Consolidated Statements of Operations for the six months ended June 30, 2017 and 2016 (Unaudited)

F-2

Consolidated Statements of Cash Flows for the six months ended June 30, 2017 and 2016 (Unaudited)

F-3

Notes to Interim Unaudited Consolidated Financial Statements

F-4

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

2

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

8

ITEM 4.

Controls and Procedures

8

PART II. OTHER INFORMATION

ITEM 1.

Legal Proceedings

9

ITEM 1A.

Risk Factors

9

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

9

ITEM 3.

Defaults Upon Senior Securities

9

ITEM 4.

Mine Safety Disclosures

9

ITEM 5.

Other Information

10

ITEM 6.

Exhibits

11

SIGNATURES

12

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DRONE AVIATION HOLDING CORP.

CONSOLIDATED BALANCE SHEETS

6/30/2017

12/31/2016

(Unaudited)

ASSETS

CURRENT ASSETS:

Cash

$

719,315

$

2,015,214

Accounts receivable - trade

24,549

394,000

Inventory, net

636,349

459,885

Prepaid expenses and deposits

57,452

120,614

Total current assets

1,437,665

2,989,713

PROPERTY AND EQUIPMENT, at cost:

180,302

179,627

Less - accumulated depreciation

(78,345

)

(60,784

)

Net property and equipment

101,957

118,843

OTHER ASSETS:

Goodwill

99,799

99,799

Intangible assets, net

1,143,667

1,289,667

Total other assets

1,243,466

1,389,466

TOTAL ASSETS

$

2,783,088

$

4,498,022

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:

Accounts payable - trade and accrued liabilities

$

97,014

$

293,922

Accounts payable due to related party

136,110

46,849

Related
party convertible note payable - Series 2016, net of discount of $2,092,156

-

907,844

Derivative liability

780,165

1,832,013

Total current liabilities

1,013,289

3,080,628

LONG
TERM LIABILITIES:

Related
party convertible note payable - Series 2016, net of discount of $999,664

The accompanying notes are an integral
part of these unaudited consolidated financial statements.

F-3

Drone Aviation Holding Corp.

Notes to Interim Unaudited Consolidated
Financial Statements

For the Period Ended June 30, 2017

1.

BASIS OF PRESENTATION

The following unaudited interim
consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.
Accordingly, such interim financial statements do not include all the information and footnotes required by accounting principles
generally accepted in the United States for complete annual financial statements. The information furnished reflects all adjustments,
consisting only of normal recurring items which are, in the opinion of management, necessary in order to make the financial statements
not misleading. The balance sheet as of December 31, 2016 has been derived from the Company’s annual financial statements
that were audited by an independent registered public accounting firm, but does not include all of the information and footnotes
required for complete annual financial statements. The consolidated financial statements included in this Quarterly Report on Form
10-Q should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s
Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

Uses and Sources of Liquidity

At June 30, 2017, the Company had cash of $719,315, working capital of $424,376, and an accumulated deficit
of $22,558,884. Furthermore, the Company has a history of negative cash flow from operations, primarily due to heavy investment
in research and development and costs associated with maintaining a public entity. In October 2016, the company issued $3,000,000
in Convertible Notes Payable with a maturity date of October, 2017. As further discussed in Note 6 – Related Party Convertible
Notes Payable and Derivative Liability, the Company does not currently have the liquid resources to repay the notes. On August
3, 2017, the notes were extended to April 1, 2019 and reclassified as long term liability as of the balance sheet date. On August
2, 2017, the Company closed on a bank line of credit in the amount of $2,000,000 and guaranteed by the Company’s Chairman
and CEO and a private line of credit with a related party investor who is a significant shareholder in the amount of $2,000,000.
The Company expects this financial backing has strengthened the balance sheet to support the level of sales necessary to maintain
positive working capital and sufficient liquidity for operations.

The Company expects that it will
need to raise substantial additional capital to accomplish its business plan over the next several years. In addition, the Company
may wish to selectively pursue possible acquisitions of businesses, technologies, or products complementary to those of the Company
in the future in order to expand its presence in the marketplace and achieve operating efficiencies. The Company expects to seek
to obtain additional funding through a bank credit facility or private equity. There can be no assurance as to the availability
or terms upon which such financing and capital might be available.

2.

RELATED PARTY TRANSACTIONS

The Company accounts for related
party transactions in accordance with ASC 850 (“Related Party Disclosures”). A party is considered to be related to
the Company if the party directly or indirectly or through one or more intermediaries, controls, is controlled by, or is under
common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate
families of principal owners of the Company and its management and other parties with which the Company may deal if one party controls
or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties
might be prevented from fully pursuing its own separate interests. A party which can significantly influence the management or
operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly
influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate
interests is also a related party.

As of June 30, 2017 and December
31, 2016, there was $136,110 and $46,849 accrued interest payable, respectively, to related parties on convertible notes payable.

F-4

3.

INVENTORY

Inventories are stated at the
lower of cost or market, using the first-in first-out method. Cost includes materials, labor and manufacturing overhead related
to the purchase and production of inventories. We regularly review inventory quantities on hand, future purchase commitments with
our supplies, and the estimated utility of our inventory. If the review indicates a reduction in utility below carrying value,
we reduce our inventory to a new cost basis through a charge to cost of goods sold. Allowance for slow moving items increased $6,366
due to a type of aerostat material which was custom ordered. Inventory consists of the following at June 30, 2017 and December
31, 2016:

June 30, 2017

December 31, 2016

Raw Materials

$

102,587

$

48,014

Work in Progress

271,346

254,258

Finished Goods

271,988

160,819

Less valuation allowance

(9,572

)

(3,206

)

Total

$

636,349

$

459,885

4.

PROPERTY AND EQUIPMENT

Property and equipment is recorded
at cost when acquired. Depreciation is provided principally on the straight-line method over the estimated useful lives
of the related assets, which is 3-7 years for equipment, furniture and fixtures, hardware and software and leasehold improvements. During
the six months ended June 30, 2017, the Company invested $675 in shop machinery and equipment. Depreciation expense was $17,561
and $16,572 for the six months ended June 30, 2017 and 2016, respectively. Property and equipment consists of the following at
June 30, 2017 and December 31, 2016:

June 30, 2017

December 31, 2016

Shop machinery and equipment

$

87,704

$

87,029

Computers and electronics

35,270

35,270

Office furniture and fixtures

37,814

37,814

Leasehold improvements

19,514

19,514

180,302

179,627

Less - accumulated depreciation

(78,345

)

(60,784

)

$

101,957

$

118,843

5.

INTANGIBLE ASSETS

On July 20, 2015, the Company,
through its wholly-owned subsidiary Drone AFS Corp., purchased substantially all the assets of Adaptive Flight, Inc. (“AFI”),
a Georgia corporation. The Company purchased assets, including, but not limited to, intellectual property, licenses and permits,
including commercial software licenses for the “GUST” (Georgia Tech UAV Simulation Tool) autopilot system and other
transferable licenses which include flight simulation and fault tolerant flight control algorithms. The Company paid $100,000 in
immediately available funds and $100,000 to be held in escrow. In addition, the Company issued 150,000 shares of unregistered common
stock valued at $8.40 per share, on a post-October 29, 2015 reverse stock split basis, on the date of agreement, to be held in
escrow.

F-5

The Company had a milestone of
twelve months to complete a technology integration plan, the non-completion of which could result in the return of the purchased
assets and termination of the Company’s obligations to release the escrow cash and shares. Additional milestones included
exclusive, no-cost and perpetual licenses to all contributing intellectual property included or related to the purchased assets.
As such time as all milestones were met, one-half of the escrow shares were to be released to AFI. Upon termination of the escrow
agreement, anticipated to be twelve months from the closing of the asset purchase, if all milestones had been met, the remaining
escrow shares would be released to AFI; but if all milestones have not been met, the escrow cash and escrow shares would be released
to the Company and the purchased assets would be returned to AFI. According to the terms of the Escrow Agreement, if the escrow
share value was less than $1,400,000, the Company must issue an additional number of unregistered shares, not to exceed 50,000
shares. At December 31, 2015, the value of the 150,000 shares was $3.23 per share, or $484,500. The Company recorded $161,500 as
an additional liability and expense at December 31, 2015 for the cost of 50,000 shares at $3.23 per share. On June 3, 2016, the
Integration Plan was deemed to be completed. At June 3, 2016, the value of the 150,000 shares was $3.01 per share, or $451,150.
The additional liability was reduced to $150,500 for the cost of 50,000 shares at $3.01 per share. The Company recorded the $11,000
reduction in the additional liability through the statement of operations at June 3, 2016. The Company began amortizing the $1,460,000
of purchased assets over a sixty month period on June 3, 2016 in the amount of $24,333 per month. Total amortization expense for
the six months ended June 30, 2017 was $146,000. The remaining unamortized balance of $1,143,667 is estimated be amortized in the
estimated amounts of $292,000 per year for 2017 through 2020 and $121,667 in 2021.

The asset acquisition did not
qualify as a business combination under ASC 805-10 and has been accounted for as a regular asset purchase.

6.

RELATED PARTY CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY

On September 29, 2016, the Company
issued Convertible Promissory Notes Series 2016 due October 1, 2017 in the aggregate principal amount of $3,000,000 in a private
placement to the Chairman of the Board and the Chairman of the Strategic Advisory Board of the Company, both of whom are greater
than 10% shareholders of the Company. The notes bear interest at a rate of six percent (6%) per annum. The Company may prepay the
notes at any time without penalty. If the Company does not prepay a note in full or the holder does not convert the note before
the maturity date, the Company may pay the outstanding principal amount and any accrued and unpaid interest on the maturity date
with cash or with common stock or through a combination of cash and stock at the Company’s discretion. The conversion price
of the notes is the lesser of $3.00 per share or eight-five percent (85%) of the lowest per share purchase price of common stock
in the next sale of common stock in which the Company receives gross proceeds of an amount greater than or equal to $3,000,000.

On August 3, 2017, the conversion
price of the notes was modified to $1.00 per share and the maturity date was extended to April 1, 2019.

Under ASC 815, these notes require
liability classification and must be measured at fair value at the end of each reporting period.

The
following table sets forth, by level within the fair value hierarchy, the Company’s financial liabilities that were accounted
for at fair value as of June 30, 2017 and December 31, 2016:

Level 1

Level 2

Level 3

Total

LIABILITIES:

Derivative liabilities as of June 30, 2017

$

0

$

0

$

780,165

$

780,165

Derivative liabilities as of December 31, 2016

$

0

$

0

$

1,832,013

$

1,832,013

F-6

The
following table represents the change in the fair value of the derivative liabilities during the six months ended June 30, 2017
and the year ended December 31, 2016:

Fair value of derivative liabilities as of December 31, 2015

$

0

Fair value of derivative liability at September 30, 2016 recorded as debt discount

2,394,974

Change in fair value of derivative liabilities

(562,961

)

Fair value of derivative liabilities as of December 31, 2016

$

1,832,013

Change in fair value of derivative liabilities

(1,051,848

)

Fair value of derivative liabilities as of June 30, 2017

$

780,165

The amortization of the debt discount is $1,092,492 and $302,818 for the six months ended June 30, 2017
and the year ended December 31, 2016, respectively. The $3,000,000 payable associated with the Convertible Promissory Notes Series
2016 due October 1, 2017 is $2,000,336 as of June 30, 2017, net of a $999,664 debt discount which is being amortized over the life
of the loan using the effective interest method. On August 3, 2017 the notes were amended to extend the maturity date to April
1, 2019 and, accordingly, they have been reclassified as long term liability as of June 30, 2017.

7.

SHAREHOLDERS’ EQUITY

In September 2016, the Company issued
1,349,000 shares of restricted common stock outside of the 2015 Equity Plan to Jay Nussbaum, Felicia Hess, Daniyel Erdberg, Kendall
Carpenter, Mike Silverman and Reginald Brown pursuant to Stock Award Agreements. The shares will vest upon consummation of a significant
equity and/or debt financing of at least $5,000,000 provided that the holder remains engaged by the Company through the vesting
date. On August 3, 2017, these awards were modified as described further in Footnote #12. Stock based compensation of $970,067
was recognized during the six months ended June 30, 2017.

In May 2016, the Company issued
150,000 shares of common stock with monthly vesting provisions to Strategic Advisory Board members, Dr. Philip Frost and Steven
Rubin, for 12 months of services. The advisors can earn a pro rata portion of the shares, calculated based on the twelve-month
vesting period, in the event the service agreements are terminated prior to the expiration date as described in the agreements.
These shares vested during May 2017. The Company recognized a total of $29,500 and $75,000 expense for the pro rata portion of
shares earned by the two members during the six months ended June 30, 2017 and 2016, respectively.

In April 2016, the Company issued
an aggregate of 1,150,000 shares of common stock outside of the 2015 Equity Plan to Jay Nussbaum, Felicia Hess, Daniyel Erdberg,
Kendall Carpenter, and Kevin Hess pursuant to Stock Award Agreements. Stock based compensation of $1,115,500 was recognized during
the six months ended June 30, 2016 on the awards which fully vested on September 29, 2016. That same month, the Company issued
100,000 shares of stock to a director who subsequently resigned and forfeited the shares. The Company recognized a total of $24,250
stock compensation during the six months ended June 30, 2016.

On September 4, 2015, the Company
issued 450,000 shares of restricted common stock to four management employees and one director pursuant to stock award agreements.
Stock based compensation of $604,440 was recognized during the six months ended June 30, 2016.

On June 1, 2015, the Company issued
50,000 shares of restricted common stock with monthly vesting provisions to the Chairman of the Board for twenty-four months services
pursuant to a Director Agreement. The Chairman can earn a pro rata portion of the shares, calculated on a twenty-four month vesting
period, in the event the Chairman relinquishes his position and Board seat prior to the expiration date of the Director Agreement.
These shares vested on June 1, 2017. The Company recognized a total of $135,000 expense for the portion of such shares earned by
the Chairman during the six months ended June 30, 2017 and 2016, respectively.

On April 24, 2017, the holder
of Series A preferred stock converted a total of 100,100 shares of Series A for an aggregate of 250,250 shares of restricted common
stock in accordance with their conversion rights which includes a blocker with respect to individual ownership percentages.

F-7

8.

PREFERRED STOCK

All of the preferred stock of
the Company is convertible into common shares. The Series A stock conversion ratio is 1 to 2.5 common shares. All preferred stock
has voting rights equal to the number of shares it would have on an ‘as if converted’ basis subject to any ownership
limitations governing such preferred shares. All preferred stock is entitled to dividends rights equal to the number of shares
it would have on an ‘as if converted’ basis. None of the preferred stock is redeemable, participating nor callable.

The Company analyzed the embedded
conversion option for derivative accounting consideration under ASC 815-15 “Derivatives and Hedging” and determined
that the conversion option should be classified as equity.

On April 24, 2017, the holder
of Series A preferred stock converted a total of 100,100 shares of Series A for an aggregate of 250,250 shares of restricted common
stock in accordance with their conversion rights which includes a blocker with respect to individual ownership percentages.

9.

EMPLOYEE STOCK OPTIONS

One June 1, 2015, the Company
issued an option award to an employee for 37,500 shares vesting over three years with an exercise price of $10.80 and expiration
date of May 4, 2019. During the six months ended June 30, 2017 and 2016, $37,734 and $80,226 compensation expense was recognized
on these 37,500 options, respectively.

On January 9, 2017, the Company
issued an option to purchase 100,000 shares of common stock with an exercise price of $2.90 per share to a director. The option
vests 50,000 after one year from grant date and another 50,000 two years from grant date with an expiration date of four years
from grant date provided that the Director is still providing service to the Company.

The Company used the Black-Scholes
option pricing model to estimate the fair value on the date of grant of the 100,000 options granted during the six months ended
June 30, 2017.

The following table summarizes
the assumptions used to estimate the fair value of the 100,000 stock options granted during the six months ended June 30, 2017
on the date of grant.

2017

Expected dividend yield

0

%

Expected volatility

100

%

Risk-free interest rate

1.50

%

Expected life of options

2.50-3.00 years

Under the Black-Scholes option
pricing model, the fair value of the 100,000 options granted during the six months ended June 30, 2017 is estimated at $174,173
on the date of grant. During the six months ended June 30, 2017, $64,530 compensation expense was recognized on these 100,000 options.

During 2016, the Company granted
65,000 common stock options to employees for service provided. Of these, 50,000 options were granted to two employees and were
immediately vested with an exercise price of $2.91 and the expiration date is April 27, 2019. One of these employees terminated
and did not exercise her 10,000 options resulting in the expiration of the option. Another 5,000 options were immediately vested
and were granted with an exercise price of $3.77 and the expiration date is July 29, 2019. Another employee received 10,000 options
with two-year vesting and an exercise price of $3.00 and an expiration date of December 6, 2019. The employee who received 5,000
options in July 2016 was terminated and did not exercise his options resulting in the expiration of a total of 5,000 options. The
Company recognized $95,649 in compensation for the first six months ended June 30, 2016 on these options.

F-8

The Company used the Black-Scholes
option pricing model to estimate the fair value on the date of grant of the 10,000 stock-based awards that continue to vest during
the six months ended June 30, 2017.

The following table summarizes
the assumptions used to estimate the fair value of the 10,000 outstanding stock options granted during 2016 on the date of grant:

2016

Expected dividend
yield

0

%

Expected volatility

102

%

Risk-free interest
rate

1.24-1.38

%

Expected life of
options

2.00-2.50 years

Under the Black-Scholes option
price model, fair value of the options granted during 2016 is estimated at $16,889 on the date of grant. During the six months
ended June 30, 2017, $6,236 compensation expense was recognized on these 10,000 options.

The following table represents
stock option activity as of and for the six months ended June 30, 2017:

Number of Options

Weighted AverageExercise Price per Share

Weighted Average Contractual Life in Years

Aggregate
Intrinsic Value

Outstanding – December 31, 2016

442,500

$

5.81

$

1.72

Exercisable – December 31, 2016

407,500

$

5.57

$

1.65

$

0

Granted

100,000

$

2.90

Exercised or Vested

12,500

$

10.80

Cancelled or Expired

(7,500

)

$

4.18

Outstanding – June 30, 2017

535,000

$

5.29

1.18

$

0

Exercisable – June 30, 2017

412,500

$

5.75

1.17

$

0

10.

WARRANTS

The Company did not issue any
warrants during the six months ended June 30, 2017.

For the year 2016, 60,000 common
stock purchase warrants were granted to four consultants for services provided. Each warrant was granted with the exercise price
of $2.91, which immediately vested, and the expiration date is April 27, 2019. The Company recognized $114,779 in compensation
cost during the six months ended June 30, 2016.

During 2016, 10,472 warrants
expired that were issued in 2011 with exercise prices ranging between $141.00 and $404.50 on a post-reverse split basis.

F-9

The Company used the Black-Scholes
warrant pricing model to estimate the fair value on the re-measurement dates of the 12,500 warrants that continue to vest during
the six months ended June 30, 2017.

The following table summarizes
the assumptions used to estimate the fair value of the 12,500 warrants granted during 2015 as of re-measurement dates:

2017

Expected dividend yield

0

%

Expected volatility

107

%

Risk-free interest rate

1.53

%

Expected life of warrants

1.0 years

Under the Black-Scholes warrant
pricing model, fair value of the 12,500 warrants granted during 2015 is estimated at $0 as of re-measurement dates. During the
six months ended June 30, 2017, $(4,899) compensation expense was recognized on these 12,500 warrants. During the six months
ended June 30, 2016, $4,995 compensation expense was recognized on these warrants.

The following table represents
warrant activity as of and for the period ended June 30, 2017:

Number of Warrants

WeightedAverageExercise Price per Share

Weighted Average Contractual Life in Years

Aggregate
Intrinsic Value

Outstanding – December 31, 2016

183,737

$

7.35

2.70

Exercisable – December 31, 2016

171,237

$

7.15

2.79

$

0

Granted

0

$

0

Forfeited or Expired

0

$

0

Outstanding – June 30, 2017

183,737

$

7.35

2.21

$

0

Exercisable – June 30, 2017

183,737

$

7.35

2.21

$

0

11.

COMMITMENTS AND CONTINGENCIES

On May 16, 2016, Banco Popular
North America (“Banco”) filed a lawsuit in Duval County, Florida in the Circuit Court of the Fourth Judicial Circuit
against Aerial Products Corporation d/b/a Southern Balloon Works (“Aerial Products”), Kevin M. Hess, LTAS, and the
Company to collect on a delinquent Small Business Administration loan that Banco made in 2007 to Aerial Products with Mr. Hess
as the personal guarantor. LTAS and the Company filed an Answer on June 30, 2016 and Responses to Interrogatories on December 16,
2016. It is our position that neither LTAS nor the Company are continuations of Aerial Products, and LTAS and the Company have
denied all allegations made by Banco and will vigorously defend that position. The Company has evaluated the probability of loss
as possible but the range of loss is unable to be estimated.

Other than the Banco matter, there
are no material claims, actions, suits, proceedings inquiries, labor disputes or investigations pending.

12.

SUBSEQUENT EVENTS

Revolving Line of Credit from City National Bank
of Florida

On August 2, 2017, the Company issued a promissory note to City National Bank of Florida (“CNB”)
in the principal amount of $2,000,000, the CNB Note. The note evidences a revolving line of credit with advances that may be requested
by the Company until the maturity date of August 2, 2018 so long as no event of default exists under the note, the Company or Mr.
Nussbaum does not cease doing business, Mr. Nussbaum does not seek to revoke or modify his guarantee of the Note, the Company does
not misapply the proceeds of this loan or CNB in good faith does not believe itself insecure. The CNB Note bears interest at a
variable rate equal to 0.250 percentage points over the Wall Street Journal Prime Rate payable monthly. The Company will pay to
CNB a late charge of 5.0% of any monthly payment not received by Lender within 10 calendar days after its due date. The Company
may prepay the note at any time without penalty. In the event of a default, the interest rate will increase to the highest lawful
rate. The Company is obligated to maintain depository accounts with CNB with a minimum average annual balance of $600,000. In the
event the Company does not maintain this account balance, CNB may charge the Company a fee equal to 2% of the deficiency as additional
interest under the note. The CNB Note is personally guaranteed by Mr. Nussbaum, the Company’s Chief Executive Officer pursuant
to written guarantee in favor of CNB (the “CNB Guarantee”). Mr. Nussbaum and the Company are obligated to maintain
an unencumbered liquidity of no less than $6,000,000 in the form of cash, repurchase agreements, certificates of deposit or marketable
securities acceptable to CNB. In addition, to secure our obligations under the note, we entered into a security agreement in favor
of CNB (the “Security Agreement”) encumbering all of our accounts, inventory and equipment along with an assignment
of a bank account we maintain at CNB with an approximate balance of $90,000.

F-10

Indemnification Agreement

On August 3, 2017, the Company
entered into an Indemnification Agreement with Mr. Nussbaum in order to indemnify and defend him to the fullest extent permitted
by law for any claim, expense or obligation which might arise as a result of his guarantee of the CNB Note.

Series 2017 Secured Convertible Note

On the Effective Date, the Company
issued a Secured Convertible Promissory Note Series 2017 due August 2, 2018 in the aggregate principal amount of $2,000,000 (the
“Series 2017 Convertible Note”) in a private placement to Frost Nevada Investments Trust (“Frost Nevada”).
Frost Nevada is a trust that is controlled by Dr. Frost, a substantial shareholder of the Company. The note evidences a revolving
line of credit with advances that may be requested by the Company until the maturity date of August 2, 2018 so long as no event
of default exists under the loan. The Company may request advances of principal under this note equal to and at the same time as
it requests advances, if any, pursuant to the CNB Note. The note bears interest at a variable rate equal to 0.250 percentage points
over the Wall Street Journal Prime Rate. The Company may prepay the notes at any time without penalty. If the Company does not
prepay the note in full or the holder does not convert the note before the maturity date, the Company may pay the outstanding principal
amount and any accrued and unpaid interest on the maturity date with cash or with common stock or through a combination of cash
and stock at Frost Nevada’s discretion. The conversion price under the note is $1.00 per share subject to proportional adjustment
in the event of stock splits, stock dividends and similar corporate events. The Series 2017 Convertible Note is secured by a security
interest in all of the Company’s assets. This security interest is subordinate to the security interest of CNB discussed
above.

Amendments to Related Party Convertible Promissory
Notes

On August 3, 2017 (the “Effective
Date”), the Company entered into amendments (the “Convertible Note Amendments”) with the owners and holders of
the following convertible promissory notes issued by the Company (the “Convertible Notes”):

●

Convertible Promissory Note in the original principal amount of $1,500,000 issued by the Company on September 29, 2016 to Frost
Gamma Investments Trust (“Frost Gamma”). Frost Gamma is a trust that is controlled by Dr. Phillip Frost, a substantial
shareholder of the Company; and

●

Convertible Promissory Note in the original principal amount of $1,500,000 issued by the Company on September 29, 2016 to Jay
H. Nussbaum, the Company’s Chief Executive Officer and Chairman of the Board of Directors.

The Convertible Note Amendments
extend the maturity date for each of the Convertible Notes to April 1, 2019 (the “Maturity Date”) and revise the conversion
price to mean $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar corporate
events. Consistent with the original terms of the Convertible Notes, interest accrues at the rate of 6% interest per annum and
is payable on the Maturity Date. The accrued interest is payable at the holders’ option in cash or shares of our common stock
valued at the $1.00 per share conversion price. The Convertible Note Amendments provide that an event of default in the City National
Bank Loan will be treated as an event of default under the Convertible Notes.

Amendments to Restricted Stock Agreements

On the Effective Date, the Company
entered into amendments (the “RSA Amendments”) with the holders of 1,349,000 shares of restricted common stock awarded
to them by the Company pursuant to the terms of a Restricted Stock Agreement (the “RSA”). Pursuant to the RSA Amendments,
the restrictions set forth in the RSA lapse upon the earlier of (i) consummation of a significant equity and/or debt financing
from which the Company receives gross proceeds of at least $7,000,000 or (ii) a change in control (as defined in the RSA Amendment),
provided that, in either case, the holder remains engaged by the Company through the date of such event.

Independent Contractor Agreements

On the Effective Date, the Company
entered into an amendment to the August 24, 2014 Independent Contractor Agreements it entered into with Dr. Philip Frost and Steven
Rubin who serve as members of the Company’s Strategic Advisory Board (the “SAB Amendments”). The SAB Amendments
extend the term of the agreements from May 1, 2017 until April 30, 2018 and provide for the following equity based compensation:
(a) for Dr. Frost, a warrant to purchase 2,000,000 shares of the Company’s Common Stock (the “Frost Warrant”)
and an award of 150,000 shares of the Company’s unregistered restricted Common Stock and (b) for Mr. Rubin, an award of 100,000
shares of the Company’s unregistered restricted Common Stock. The restricted stock vests upon the occurrence of a change
of control (as defined in the SAB Amendments). The Warrant has a term of five years and exercise price of $1.00 per share subject
to proportional adjustment in the event of stock splits, stock dividends and similar corporate events.

Options issued

On August 3, 2017, upon
approval of the Company’s board of directors, the Company issued outside its 2015 Equity Plan, 5,240,000 options to
purchase the Company’s common stock to officers, directors and employees for services provided. Jay Nussbaum was issued
2,000,000 options, Felicia Hess was issued 1,200,000 options, Dan Erdberg was issued 1,140,000 options, Kendall Carpenter was
issued 275,000 options, Directors David Aguilar, Mike Haas and General Wayne Jackson were issued 110,000, 10,000 and 10,000
options, respectively. The remaining 495,000 options were issued to employees and consultants. These stock options
immediately vested, are exercisable at an exercise price of $1.00 per share and expire on August 3, 2021.

F-11

ITEM 2. MANAGEMENT’S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain statements
in Management's Discussion and Analysis (“MD&A”), other than historical information, including estimates, projections,
statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements
are based, are "forward-looking statements". Forward-looking statements generally can be identified by the use of forward-looking
terminology, such as “may,” “would,” “expect,” “intend,” “could,” “estimate,”
“should,” “anticipate,” “believe,” and similar expressions. Forward-looking statements
are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to
differ materially from the forward-looking statements. These statements are subject to a number of risks, uncertainties and developments
beyond our control or foresight, including changes in the trends of the advanced aerostats and tethered drone industry, formation
of competitors, changes in governmental regulation or taxation, changes in our personnel and other such factors. We
undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future
events, or otherwise. Readers should carefully review the risk factors and related notes included under Item 1A of our
Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission on March 17,
2017.

The following MD&A
is intended to help readers understand the results of our operations and financial condition and is provided as a supplement to,
and should be read in conjunction with, our Unaudited Consolidated Financial Statements and the accompanying Notes to Unaudited
Consolidated Financial Statements under Part I, Item 1 of this Quarterly Report on Form 10-Q.

Growth and percentage
comparisons made herein generally refer to the six months ended June 30, 2017 compared with the six months ended June 30, 2016
unless otherwise noted. Unless otherwise indicated or unless the context otherwise requires, all references in this document to
“we,” “us,” “our,” the “Company,” and similar expressions refer to Drone Aviation
Holding Corp. and, depending on the context, its subsidiaries.

Business Overview

We design, develop,
market and sell lighter-than-air (“LTA”) advanced aerostats, tethered drones, and land-based intelligence, surveillance
and reconnaissance (“ISR”) solutions. We focus on the development of a tethered aerostat known as the Winch Aerostat
Small Platform (“WASP”), as well as tethered drone products, including the WATT and BOLT electric tethered drones launched
on March 2, 2015 and July 13, 2016, respectively. The WATT and BOLT products are designed for commercial and military applications
and provide secure and reliable aerial monitoring for extended durations while being tethered to the ground via a high strength
armored tether. We also developed FUSE, a cost-effective tether kit for DJI Inspire drones. The FUSE winch offers better control
in stronger winds for flights up to 200 feet and offers continuous power distribution monitoring and unlimited flight time.

While sales in the
past quarter decreased compared to the same period in 2016, this decrease was primarily a result of a longer sales cycle stemming
in part from the recent change in administration and congressional budgeting delays. We expect increased sales in future periods
based on a product pipeline that is developing following our increased marketing efforts and our announcement of the following:

·

On March 1, 2017, we announced the successful
integration of government-furnished ISR equipment supporting the simultaneous use of communications and optical payload packages
onto an enhanced WASP aerostat for the Department of Defense.

·

On May 9, 2017, we announced the new heavy
lift WATT 300 Multirotor Tethered Drone and recently upgraded WASP Military Aerostat platforms at SOFIC 2017.

·

On May 25, 2017, we announced our new
product called FUSE which is an automated smart winch tethering system designed to meet the unique specifications for DJI Inspire
drones, the world’s most popular commercial drone.

Our marketing efforts
include submission of bids on a several government procurement projects that we expect will be awarded in 2017 and 2018. We also
showcased our products and technologies at numerous conferences and live demonstrations, including the 2017 Special Operations
Forces Industry Conference, Warrior Expo East, State of Florida HURREX exercise, CyberQuest 2017, and presentations to a variety
of federal and state government agencies. In anticipation of increased sales resulting from our developing product pipeline, we
completed financing transactions that provide us with up to $4,000,000 in cash and extended the maturity date on $3,000,000 of
convertible debt until April 2019 providing us with significant increased liquidity and a strengthened balance sheet. While there
is no assurance that the opportunities included in our developing pipeline will result in orders for our products, we have positioned
ourselves to be able to deliver the goods and services we have bid on.

In addition to our
plans to organically grow our lighter than air systems through increased marketing and sales, we intend to continue to consider
potential strategic transactions, which could involve acquisitions of businesses or assets, joint ventures or investments in businesses,
products or technologies that expand, complement or otherwise relate to our current or future business.

2

Results of Operations

Three Months Ended June 30, 2017 compared
to Three Months Ended June 30, 2016

Revenues: Revenues
of $13,876 for the quarter ended June 30, 2017 decreased $470,138 or 97% from $484,014 for the same period in 2016. Sources
of revenue were derived primarily from aerostat products and accessories. The decrease in sales volume was primarily a result
of a longer sales cycle stemming in part from the recent change in presidential administration and congressional budgeting delays.
We expect increased sales in future periods based on a product pipeline developed following our increased marketing efforts discussed
in the Business Overview section above.

Cost of Goods Sold
and Gross Profit: Cost of goods sold of $6,466 for the quarter ended June 30, 2017 decreased $169,109 or 96% from
$175,575 for the same period in 2016. Costs included materials, parts and labor associated with the sale of aerostat products and
accessories. The $7,410 gross profit for the quarter ended June 30, 2017 was a decrease of $301,209 or 98% from the $308,439 in
gross profit for the same quarter of 2016. Gross profit margins were 53% and 64% for the quarters ended June 30, 2017
and 2016, respectively.

General and Administrative
Expense: General and administrative expense primarily consists of payroll and related costs, sales and marketing
costs, research and development costs, business overhead and costs related to maintaining a public entity. General and
administrative expenses decreased $1,091,380 or 44% to $1,367,758 in the quarter ended June 30, 2017 from $2,459,138 for the same
period in 2016. Contributing to the decrease was non-cash stock-based compensation of $604,559 for the quarter ended June 30, 2017,
a decrease of $928,063 from $1,532,622 in the same period in 2016. Research and development costs decreased $244,138 due to drone
products becoming ready for market, partially offset by an amortization expense increase of $48,667 related to assets acquired
from AFI in 2015 and fully integrated in 2016, and an increase in payroll of $76,739.

Loss from Operations: Loss
from operations for the quarter ended June 30, 2017 decreased $790,350 or 37% to $1,360,349 from loss from operations of $2,150,699
for the same period in 2016. The decrease was primarily due to a decrease in gross profit of $301,029 and offset by the decrease
of general and administrative expense of $1,091,379 as discussed above.

Other Expense: Total
other expense of $402,356 for the quarter ended June 30, 2017 was $413,216 greater than the total other income of $10,860 in the
same period in 2016. This increase was primarily due to $298,050 non-cash income due to a change in fair value of derivative
liabilities, partially offset by an increase of $44,877 in accrued interest expense on the related party convertible notes payable
and $655,530 debt discount charged to interest expense. The Company will continue to incur interest expense in 2017 on the related
party convertible notes payable and will continue to record derivative gains or losses related to those notes until they are converted.

Net Loss: Net
loss decreased $377,134 or 18% to $1,762,705 for the quarter ended June 30, 2017 from net loss of $2,139,839 for the same period
in 2016. The decrease in net loss was due to factors discussed above.

3

Six Months Ended June 30, 2017 compared
to Six Months Ended June 30, 2016

Revenues: Revenues
of $381,529 for the six months ended June 30, 2017 decreased $545,935 or 59% from $927,464 for the same period in
2016. Sources of revenue were derived primarily from aerostat products, refurbishments and accessories ordered in 2016
and delivered in 2017. The reason for the decrease is that revenues in the first half of 2017 were primarily related to
refurbishments and enhancements of aerostat systems and the revenues in the first half of 2016 were primarily from the sale
of an aerostat system. Also contributing to the decrease in sales volume was a longer sales cycle stemming in part from the
recent change in presidential administration and congressional budgeting delays. We expect increased sales in future
periods based on a product pipeline developed following our increased marketing efforts discussed in the Business Overview
section above.

Cost of Goods Sold
and Gross Profit: Cost of goods sold of $249,996 for the six months ended June 30, 2017 decreased $59,465 or 19%
from $309,461 for the same period in 2016. Costs in both periods included materials, parts and labor associated with the sale of
aerostat products, refurbishments and accessories. The aerostat system delivered in the first quarter of 2016 had a 73% gross profit
margin which was greater than the gross profit realized in the first quarter of 2017 on aerostat system refurbishments due to the
increased time and material costs to disassemble and reassemble refurbished systems. The $131,533 gross profit for the six months
ended June 30, 2017 was a decrease of $486,470 or 79% from the $618,003 in gross profit for the same period of 2016. Gross
profit margins were 34% and 67% for the six months ended June 30, 2017 and 2016, respectively.

General and Administrative
Expense: General and administrative expense primarily consists of payroll and related costs, sales and marketing
costs, research and development costs, business overhead and costs related to maintaining a public entity. General and
administrative expenses decreased $1,121,351 or 28% to $2,887,727 in the six months ended June 30, 2017 from $4,009,078 for the
same period in 2016. Contributing to the decrease was non-cash stock-based compensation of $1,238,168 for the six months ended
June 30, 2017, a decrease of $1,011,671 from $2,249,839 in the same period in 2016. Research and development costs decreased $380,769
due to drone products becoming ready for market, partially offset by an amortization expense increase of $121,667 related to assets
acquired from AFI in 2015 and fully integrated in 2016, and an increase in payroll of $109,369.

Loss from Operations: Loss
from operations for the six months ended June 30, 2017 decreased $634,881 or 19% to $2,756,194 from loss from operations of $3,391,075
for the same period in 2016. The decrease was primarily due to a decrease in gross profit of $486,470 partially offset by a decrease
of general and administrative expense of $1,121,351 as discussed above.

Other Expense: Total
other expense of $129,905 for the six months ended June 30, 2017 was $140,625 less than the total other expense of $10,720 in 2016. This
decrease was primarily due to $1,051,848 non-cash income due to a change in fair value of derivative liabilities, partially offset
by an increase of $136,110 in accrued interest expense on the related party convertible notes payable and $1,092,492 debt discount
charged to interest expense. The Company will continue to incur interest expense in 2017 on the related party convertible notes
payable and will continue to record derivative gains or losses related to those notes until they are converted.

Net Loss: Net
loss decreased $494,256 or 15% to $2,886,099 for the six months ended June 30, 2017 from net loss of $3,380,355 for the same period
in 2016. The decrease in net loss was due to factors discussed above.

4

Liquidity and Capital Resources

Liquidity is the ability
of an enterprise to generate adequate amounts of cash to meet its needs for cash requirements. As of June 30, 2017, the Company
had $719,315 in cash compared to $2,015,214 in cash at December 31, 2016, a decrease of $1,295,899. As of June 30, 2017, the Company
had accounts receivable of $24,549 compared to $394,000 at December 31, 2016, a decrease of $369,451 resulting from increased collections
in the first six months of 2017.

The Company had total current assets of $1,437,665 and total current liabilities of $1,013,289, or working
capital of $424,376 at June 30, 2017 compared to total current assets of $2,989,713 and total current liabilities of $3,080,628,
or working capital deficit of $90,915 at December 31, 2016.

We have historically financed our operations through operating revenues and sales of equity and convertible
debt securities. Although as of June 30, 2017 we have cash of $719,315, we have a working capital of $424,376 and incurred a net
loss from operations of $2,756,194. Furthermore, the Company has a history of negative cash flow from operations, primarily due
to historically heavy investment in research and development and costs associated with maintaining a public entity. While we expect
a substantial reduction in research and development costs, we believe our existing working capital and access to capital are sufficient
to continue our operations for the next 12 months.

In anticipation of
increased sales resulting from our developing product pipeline, on August 2, 2017, we completed financing transactions that provide
us with up to $4,000,000 in cash and extended the maturity date on $3,000,000 of convertible debt until April 2019 providing us
with significant increased liquidity and a strengthened balance sheet. The following is a summary of these completed financing
transaction:

Revolving Line
of Credit from City National Bank of Florida. On August 2, 2017, the Company issued a promissory note to City National Bank
of Florida (“CNB”) in the principal amount of $2,000,000, the CNB Note. The note evidences a revolving line of credit
with advances that may be requested by the Company until the maturity date of August 2, 2018 so long as no event of default exists
under the note, the Company or Mr. Nussbaum does not cease doing business, Mr. Nussbaum does not seek to revoke or modify his
guarantee of the Note, the Company does not misapply the proceeds of this loan or CNB in good faith does not believe itself insecure.
The CNB Note bears interest at a variable rate equal to 0.250 percentage points over the Wall Street Journal Prime Rate payable
monthly. The Company will pay to CNB a late charge of 5.0% of any monthly payment not received by Lender within 10 calendar days
after its due date. The Company may prepay the note at any time without penalty. In the event of a default, the interest rate
will increase to the highest lawful rate. The Company is obligated to maintain depository accounts with CNB with a minimum average
annual balance of $600,000. In the event the Company does not maintain this account balance, CNB may charge the Company a fee
equal to 2% of the deficiency as additional interest under the note. The CNB Note is personally guaranteed by Mr. Nussbaum, the
Company’s Chief Executive Officer pursuant to written guarantee in favor of CNB (the “CNB Guarantee”). Mr. Nussbaum
and the Company are obligated to maintain an unencumbered liquidity of no less than $6,000,000 in the form of cash, repurchase
agreements, certificates of deposit or marketable securities acceptable to CNB. In addition, to secure our obligations under the
note, we entered into a security agreement in favor of CNB (the “Security Agreement”) encumbering all of our accounts,
inventory and equipment along with an assignment of a bank account we maintain at CNB with an approximate balance of $90,000.

Series 2017 Secured
Convertible Note. On the Effective Date, the Company issued a Secured Convertible Promissory Note Series 2017 due August 2,
2018 in the aggregate principal amount of $2,000,000 (the “Series 2017 Convertible Note”) in a private placement to
Frost Nevada Investments Trust (“Frost Nevada”). Frost Nevada is a trust that is controlled by Dr. Frost, a substantial
shareholder of the Company. The note evidences a revolving line of credit with advances that may be requested by the Company until
the maturity date of August 2, 2018 so long as no event of default exists under the loan. The Company may request advances of
principal under this note equal to and at the same time as it requests advances, if any, pursuant to the CNB Note. The note bears
interest at a variable rate equal to 0.250 percentage points over the Wall Street Journal Prime Rate. The Company may prepay the
notes at any time without penalty. If the Company does not prepay the note in full or the holder does not convert the note before
the maturity date, the Company may pay the outstanding principal amount and any accrued and unpaid interest on the maturity date
with cash or with common stock or through a combination of cash and stock at Frost Nevada’s discretion. The conversion price
under the note is $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar
corporate events. The Series 2017 Convertible Note is secured by a security interest in all of the Company’s assets. This
security interest is subordinate to the security interest of CNB discussed above.

5

Amendments to Related Party Convertible Promissory
Notes. On August 3, 2017 (the “Effective Date”), the Company entered into amendments (the “Convertible Note
Amendments”) with the owners and holders of the following convertible promissory notes issued by the Company (the “Convertible
Notes”):

●
Convertible Promissory Note in the original principal amount of $1,500,000 issued by the Company on September 29, 2016 to
Frost Gamma Investments Trust (“Frost Gamma”). Frost Gamma is a trust that is controlled by Dr. Phillip Frost, a
substantial shareholder of the Company; and

●
Convertible
Promissory Note in the original principal amount of $1,500,000 issued by the Company on September 29, 2016 to Jay H. Nussbaum,
the Company’s Chief Executive Officer and Chairman of the Board of Directors.

The Convertible Note
Amendments extend the maturity date for each of the Convertible Notes to April 1, 2019 (the “Maturity Date”) and revise
the conversion price to mean $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and
similar corporate events. Consistent with the original terms of the Convertible Notes, interest accrues at the rate of 6% interest
per annum and is payable on the Maturity Date. The accrued interest is payable at the holders’ option in cash or shares of
our common stock valued at the $1.00 per share conversion price. The Convertible Note Amendments provide that an event of default
in the City National Bank Loan will be treated as an event of default under the Convertible Notes.

Sources and Uses of Cash

Six Months Ended

June 30,

2017

2016

Cash flows (used in) operating activities

$

(1,295,224

)

$

(1,536,615

)

Cash flows (used in) investing activities

(675

)

(10,783

)

Cash flows provided by financing activities

0

0

Net (decrease) in cash and cash equivalents

$

(1,295,899

)

$

(1,547,398

)

Operating Activities

Net cash used in operating
activities during the six months ended June 30, 2017 was $1,295,899, which was a decrease of $251,499, or 16%, from $1,547,398
net cash used in operating activities during six months ended June 30, 2016. The net loss of ($2,886,099) for the first six months
of 2017 was ($494,256) less than the same period of 2016, which was ($3,380,355). In addition to the decreased net loss, the Company
recognized $1,011,671 less non-cash stock based compensation in the first six months of 2017 than the previous year, offset by
($584,506) decrease changes in working capital for the six months ended June 30, 2017 compared to the same period in 2016. The
Company recognized a non-cash gain on derivative liability of $1,051,848 offset by amortization expense of $146,000 on intangible
assets and $1,092,492 on debt discount in the first six months of 2017 which were not present during the same period of 2016.

6

Investing Activities:

Net cash used in investing
activities was $675 and $10,783 during the six months ended June 30, 2017 and 2016, respectively, which in each case was related
to purchase of shop machines and equipment, computers and electronics and furniture and equipment.

Financing Activities:

There was no cash
provided by financing activity during the six months ended June 30, 2017 or 2016.

Off-Balance Sheet Arrangements

We do not have any
off balance sheet arrangements that materially effect on our financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures, or capital resources.

Critical Accounting Policies and Estimates

The Company’s
accounting policies are more fully described in Note 1 of the Financial Statements included in the Company’s Annual Report
on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission on March 17, 2017. As disclosed
therein, the preparation of the Company’s financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ significantly from those estimates. The Company believes that the following
discussion addresses the Company’s most critical accounting policies, which are those that are most important to the portrayal
of the Company’s financial condition and results of operations and require management’s most difficult, subjective
and complex judgments.

Accounts Receivable and Credit Policies:

Accounts receivable-trade
consists of amounts due from the sale of tethered aerostats, accessories, spare parts, and customization and refurbishment of aerostats.
Such accounts receivable are uncollateralized customer obligations due under normal trade terms requiring payment within 30 days
of receipt of the invoice. We provide an allowance for doubtful accounts equal to the estimated uncollectible amounts based on
historical collection experience and a review of the current status of trade accounts receivable. At June 30, 2017 and December
31, 2016, none of the Company’s accounts receivable-trade was deemed uncollectible.

Revenue Recognition and Unearned
Revenue:

The Company recognizes
revenue when all four of the following criteria are met: 1) persuasive evidence of an arrangement exists; 2) delivery has occurred
and title has transferred or services have been rendered; 3) our price to the buyer is fixed or determinable; and 4) collectability
is reasonably assured. We record unearned revenue as a liability and the associated costs of sales as work in process inventory.
There is a balance of $24,549 in accounts receivable at June 30, 2017 for employee commission advances and no balance in unearned
revenue.

Derivative Financial Instruments:

The Company evaluates
its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives.
For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at
its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations.
For stock-based derivative financial instruments, the Company uses a Black-Scholes option pricing model, in accordance with ASC
815-15 “Derivative and Hedging” to value the derivative instruments at inception and on subsequent valuation dates.
The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity,
is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current
or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the
balance sheet date.

Stock-Based Compensation:

We account for stock-based
compensation in accordance with ASC 718, “Compensation-Stock Compensation.” ASC 718 requires companies to measure the
cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date
fair value of the award and to recognize it as compensation expense over the period the employee is required to provide service
in exchange for the award, usually the vesting period.

7

Recently Issued Accounting Pronouncements

Management does not
believe that any recently issued, but not effective, accounting standards, if currently adopted, would have a material effect on
the Company’s financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURE ABOUT MARKET RISK

As a smaller reporting
company, as that term is defined in Item 10(f)(1) of Regulation S-K, we are not required to provide information required by this
Item.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls
and procedures.

Our management, with
the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls
and procedures pursuant to Rule 13a-15 under the Exchange Act as of the end of the period covered by this Quarterly Report on Form
10-Q. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In
addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management
is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Management, with the
participation of our Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure
controls and procedures as of June 30, 2017. Based on that evaluation, our management, including our Chief Executive Officer and
Chief Financial Officer, concluded that our disclosure controls and procedures were not effective as of June 30, 2017 for the reasons
discussed below. In addition, management identified the following material weaknesses in its assessment of the effectiveness of
disclosure controls and procedures as of June 30, 2017:

The Company did not
effectively segregate certain accounting duties due to the small size of its accounting staff.

A material weakness
is a deficiency, or a combination of control deficiencies, in internal control over financial reporting such that there is a reasonable
possibility that a material misstatement of our annual or interim consolidated financial statements will not be prevented or detected
on a timely basis. Notwithstanding the determination that our internal control over financial reporting was not effective, as of
June 30, 2017, and that there was a material weakness as identified in this Quarterly Report, we believe that our consolidated
financial statements contained in this Quarterly Report fairly present our financial position, results of operations and cash flows
for the years covered hereby in all material respects.

We expect to
be dependent upon our Chief Financial Officer who is knowledgeable and experienced in the application of U.S. Generally Accepted
Accounting Principles to maintain our disclosure controls and procedures and the preparation of our financial statements for the
foreseeable future. We plan on increasing the size of our accounting staff at the appropriate time for our business and its
size to ameliorate our concern that we do not effectively segregate certain accounting duties, which we believe
would resolve the material weakness in disclosure controls and procedures, but there can be no assurances as to the timing of any
such action or that we will be able to do so.

(b) Changes in internal control over
financial reporting.

There were no changes
in our internal control over financial reporting that occurred during the quarter ended June 30, 2017 that have materially affected,
or are reasonably likely to materially affect, our internal control over financial reporting.

8

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

From time to time,
we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. Except as
discussed below, we are not currently aware of any such legal proceedings or claims that we believe will have, individually or
in the aggregate, a material adverse effect on our business, financial condition, or operating results.

On May 16, 2016, Banco
Popular North America (“Banco”) filed a lawsuit in Duval County, Florida in the Circuit Court of the Fourth Judicial
Circuit against Aerial Products Corporation d/b/a Southern Balloon Works (“Aerial Products”), Kevin M. Hess, LTAS,
and the Company to collect on a delinquent Small Business Administration loan that Banco made in 2007 to Aerial Products with Mr.
Hess as the personal guarantor. LTAS and the Company filed an Answer on June 30, 2016 and Responses to Interrogatories on December
16, 2016 and we are now in the discovery phase of litigation. It is our position that neither LTAS nor the Company are continuations
of Aerial Products, and LTAS and the Company has denied all allegations made by Banco and is vigorously defending itself. The Company
has evaluated the probability of loss as possible but the range of loss is unable to be estimated.

Other than the Banco
matter, there are no material claims, actions, suits, proceedings inquiries, labor disputes or investigations pending.

Item
1A. Risk Factors

Smaller reporting companies
are not required to provide the information required by this Item.

Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds

Series A Preferred Stock Conversion

On April 24, 2017, the holder of the Company’s
Series A preferred stock converted a total of 100,100 shares of Series A for an aggregate of 250,250 shares of the Company unregistered
common stock in accordance with their conversion rights provided for in the Series A preferred stock.

These shares of the Company’s common
stock were issued in reliance on the exemption from registration provided by Section 3(a)(9) of the Securities Act of 1933, as
amended (the “Securities Act”).

Issuance of Secured Convertible Promissory
Note

On August 2, the Company issued a Secured
Convertible Promissory Note Series 2017 due August 2, 2018 in the aggregate principal amount of $2,000,000 (the “Series 2017
Convertible Note”) in a private placement to Frost Nevada Investments Trust (“Frost Nevada”).

The Series 2017 Convertible Note was issued
in reliance upon the exemption from securities registration afforded by the provisions of Section 4(a)(2) of the Securities Act.

Issuance of Stock Options

On August 3,2017, the Company issued outside
its 2015 Equity Plan, 5,240,000 options to purchase the Company’s common stock to officers, directors and employees for services
provided. Jay Nussbaum was issued 2,000,000 options, Felicia Hess was issued 1,200,000 options, Dan Erdberg was issued 1,140,000
options, Kendall Carpenter was issued 275,000 options, Directors David Aguilar, Mike Haas and General Wayne Jackson were issued
110,000, 10,000 and 10,000 options, respectively. The remaining 495,000 options were issued to employees and consultants. These
stock options immediately vested, are exercisable at an exercise price of $1.00 per share and expire on August 3, 2021.

The Stock Options were issued in reliance
upon the exemption from securities registration afforded by the provisions of Section 4(a)(2) of the Securities Act.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

9

ITEM 5. OTHER INFORMATION

Revolving Line of Credit from City National
Bank of Florida

On August 2, 2017, the Company issued a
promissory note to City National Bank of Florida (“CNB”) in the principal amount of $2,000,000, the CNB Note. The note
evidences a revolving line of credit with advances that may be requested by the Company until the maturity date of August 2, 2018
so long as no event of default exists under the note, the Company or Mr. Nussbaum does not cease doing business, Mr. Nussbaum does
not seek to revoke or modify his guarantee of the Note, the Company does not misapply the proceeds of this loan or CNB in good
faith does not believe itself insecure. The CNB Note bears interest at a variable rate equal to 0.250 percentage points over the
Wall Street Journal Prime Rate payable monthly. The Company will pay to CNB a late charge of 5.0% of any monthly payment not received
by Lender within 10 calendar days after its due date. The Company may prepay the note at any time without penalty. In the event
of a default, the interest rate will increase to the highest lawful rate. The Company is obligated to maintain depository accounts
with CNB with a minimum average annual balance of $600,000. In the event the Company does not maintain this account balance, CNB
may charge the Company a fee equal to 2% of the deficiency as additional interest under the note. The CNB Note is personally guaranteed
by Mr. Nussbaum, the Company’s Chief Executive Officer pursuant to written guarantee in favor of CNB (the “CNB Guarantee”).
Mr. Nussbaum and the Company are obligated to maintain an unencumbered liquidity of no less than $6,000,000 in the form of cash,
repurchase agreements, certificates of deposit or marketable securities acceptable to CNB. In addition, to secure our obligations
under the note, we entered into a security agreement in favor of CNB (the “Security Agreement”) encumbering all of
our accounts, inventory and equipment along with an assignment of a bank account we maintain at CNB with an approximate balance
of $90,000.

Indemnification Agreement

On August 3, 2017, the Company entered
into an Indemnification Agreement with Mr. Nussbaum in order to indemnify and defend him to the fullest extent permitted by law
for any claim, expense or obligation which might arise as a result of his guarantee of the CNB Note.

Series 2017 Secured Convertible Note

On the Effective Date, the Company issued
a Secured Convertible Promissory Note Series 2017 due August 2, 2018 in the aggregate principal amount of $2,000,000 (the “Series
2017 Convertible Note”) in a private placement to Frost Nevada Investments Trust (“Frost Nevada”). Frost Nevada
is a trust that is controlled by Dr. Frost, a substantial shareholder of the Company. The note evidences a revolving line of credit
with advances that may be requested by the Company until the maturity date of August 2, 2018 so long as no event of default exists
under the loan. The Company may request advances of principal under this note equal to and at the same time as it requests advances,
if any, pursuant to the CNB Note. The note bears interest at a variable rate equal to 0.250 percentage points over the Wall Street
Journal Prime Rate. The Company may prepay the notes at any time without penalty. If the Company does not prepay the note in full
or the holder does not convert the note before the maturity date, the Company may pay the outstanding principal amount and any
accrued and unpaid interest on the maturity date with cash or with common stock or through a combination of cash and stock at Frost
Nevada’s discretion. The conversion price under the note is $1.00 per share subject to proportional adjustment in the event
of stock splits, stock dividends and similar corporate events. The Series 2017 Convertible Note is secured by a security interest
in all of the Company’s assets. This security interest is subordinate to the security interest of CNB discussed above.

Amendments to Related Party Convertible
Promissory Notes

On August 3, 2017 (the “Effective
Date”), the Company entered into amendments (the “Convertible Note Amendments”) with the owners and holders of
the following convertible promissory notes issued by the Company (the “Convertible Notes”):

● Convertible Promissory Note in
the original principal amount of $1,500,000 issued by the Company on September 29, 2016 to Frost Gamma Investments Trust (“Frost
Gamma”). Frost Gamma is a trust that is controlled by Dr. Phillip Frost, a substantial shareholder of the Company; and

● Convertible Promissory Note in
the original principal amount of $1,500,000 issued by the Company on September 29, 2016 to Jay H. Nussbaum, the Company’s
Chief Executive Officer and Chairman of the Board of Directors.

The Convertible Note Amendments extend
the maturity date for each of the Convertible Notes to April 1, 2019 (the “Maturity Date”) and revise the conversion
price to mean $1.00 per share subject to proportional adjustment in the event of stock splits, stock dividends and similar corporate
events. Consistent with the original terms of the Convertible Notes, interest accrues at the rate of 6% interest per annum and
is payable on the Maturity Date. The accrued interest is payable at the holders’ option in cash or shares of our common stock
valued at the $1.00 per share conversion price. The Convertible Note Amendments provide that an event of default in the City National
Bank Loan will be treated as an event of default under the Convertible Notes.

10

Amendments to Restricted Stock Agreements

On the Effective Date, the Company entered
into amendments (the “RSA Amendments”) with the holders of 1,349,000 shares of restricted common stock awarded to them
by the Company pursuant to the terms of a Restricted Stock Agreement (the “RSA”). Pursuant to the RSA Amendments, the
restrictions set forth in the RSA lapse upon the earlier of (i) consummation of a significant equity and/or debt financing from
which the Company receives gross proceeds of at least $7,000,000 or (ii) a change in control (as defined in the RSA Amendment),
provided that, in either case, the holder remains engaged by the Company through the date of such event.

Independent Contractor Agreements

On the Effective Date, the Company entered
into an amendment to the August 24, 2014 Independent Contractor Agreements it entered into with Dr. Philip Frost and Steven Rubin
who serve as members of the Company’s Strategic Advisory Board (the “SAB Amendments”). The SAB Amendments extend
the term of the agreements from May 1, 2017 until April 30, 2018 and provide for the following equity based compensation: (a) for
Dr. Frost, a warrant to purchase 2,000,000 shares of the Company’s Common Stock (the “Frost Warrant”) and an
award of 150,000 shares of the Company’s unregistered restricted Common Stock and (b) for Mr. Rubin an award of 100,000 shares
of the Company’s unregistered restricted Common Stock. The restricted stock vests upon the occurrence of a change of control
(as defined in the SAB Amendments). The Warrant has a term of five years and exercise price of $1.00 per share subject to proportional
adjustment in the event of stock splits, stock dividends and similar corporate events.

Issuance of Stock Options

On August 3,
2017, upon approval of the Company’s board of directors, the Company issued outside its 2015 Equity Plan, 5,240,000
options to purchase the Company’s common stock to officers, directors and employees for services provided. Jay Nussbaum
was issued 2,000,000 options, Felicia Hess was issued 1,200,000 options, Dan Erdberg was issued 1,140,000 options, Kendall
Carpenter was issued 275,000 options, Directors David Aguilar, Mike Haas and General Wayne Jackson were issued 110,000,
10,000 and 10,000 options, respectively. The remaining 495,000 options were issued to employees and consultants. These stock
options immediately vested, are exercisable at an exercise price of $1.00 per share and expire on August 3, 2021.

Modifications
to Executive Employment Agreements

The Board of Directors,
upon recommendation of the Compensation Committee, increased the annual salary of CEO Jay Nussbaum from $0 to $240,000 per year.
Mr. Nussbaum will forego the $48,000 per year director fee. The salaries of Daniyel Erdberg and Kendall Carpenter are being increased
from $150,000 per year to $165,000 per year. The additional benefit of a company provided car is being removed from Felicia Hess’
compensation package.

The foregoing
description of the terms of the CNB Note and Security Agreement, CNB Guarantee, Indemnification Agreement, Series 2017
Convertible Note, Convertible Note Amendments, the RSA Amendments, Executive Employment Agreement Amendments, SAB Amendments
and Frost Warrant, do not purport to be complete and are qualified in their entirety by reference to the provisions of such
agreements, the forms of which are filed as exhibits 10.29, 10.30, 10.31, 10.32, 4.2, 4.1(a), 10.4(d), 10.5(d),
10.6(c), 10.22(b),10.33, and 10.34, respectively, to this Quarterly Report on Form 10-Q.

Item
6. EXHIBITS

The Exhibits listed
in the accompanying Exhibit Index are filed, furnished herewith, or incorporated by reference as part of this Quarterly Report
on Form 10-Q, in each case as set forth in the Exhibit Index.

11

SIGNATURES

Pursuant to the requirements
of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.